Good day. Welcome to today's SKF Q1 2018 results conference call. Today's conference is being recorded. At this time, I would like to turn the conference over to Patrik Stenberg, Head of Investor Relations. Please go ahead.
Thank you. Good morning. Welcome to this conference call on the first quarter results. The conference call will, as usual, take about an hour. Present today are President and CEO, Alrik Danielson, our CFO, Christian Johansson, our Director of Group Controlling and Accounting, Carina Karlsson, and Theo Kjellberg, Press and Media Director, and myself, Patrik Stenberg. We will start, as usual, by presenting the results. We'll probably last about 30 minutes. After that, we are open to take your questions. One quick reminder about the questions. It is good if we can limit it to one or two questions so that everyone gets the opportunity to pose their questions at the end of the call. With that introduction, I'll leave the word to Alrik. Please.
Thank you very much, Patrik. Welcome. If we go to the next slide, it is a record start for SKF. It's a record quarter, a historical quarter, with record high sales of almost SEK 20.6 billion, with an organic growth of 7.5%, and an operating margin of just short of 13%, and a cash flow that, of course, could have been stronger, but was definitely much better than last year. If we go to the next slide, we have, as you know, targets. We have five key targets, and we are now delivering on three of them, and we are doing very good progress on return on capital employed. The only one that we still have some work to do is net working capital, which is in a way absolutely normal in times of high volume growth.
There will be an increase of net working capital, but I am sure that you will see good progress also on that going forward. If you take the next slide, we look a little bit more on sales growth in the different regions, and as you see, we're growing in all regions, and I am really happy to see how Europe is coming along. Asia-Pacific, Middle East, and Africa, all important segments are growing. In Europe, it's really good to see that industrial distribution is developing so well. In North America and Latin America, growth is also there. The underlying growth is there. The little bit weaker figures in Latin America is, in my mind, entirely dependent on wind.
Our large size bearing factory dedicated to wind applications has basically been standing still due to the fact that there has been no deployment of windmills in Latin America, basically during the quarter. We see, however, that we are now starting up the factory again. The same in North America. Heavy trucks is going well. We are selling strong into industrial applications, and here it's basically the wind as well. There are some businesses in wind that we have decided not to pursue, and that's the reason for a little bit lower absolute comparison figures than the underlying figures. We've talked a little bit about pricing. We've talked about how we are increasing prices, and you see now clearly that what we have been telling is coming through, and the industrial distribution VSM price increases are there, and we're working on further enhancing that.
In the industrial OEMs, wherever there's been a contract change, price increases have been implemented. In automotive, of course, with a slower pace due to the dynamics of that industry, but still also prices are coming through and being adjusted also there. If we take the next slide and talk a little bit about things that I see I'm really happy about. The rotating equipment performance is one of our key strategic initiatives. Our product and services application know-how and customer focus on new technologies starting to really give good results, and we have the suite of both products and services and knowledge to enhance our customers' performance, and I see now how this is truly starting to have effect. If you take the next slide, we all know that unplanned production stops cost the industry billions.
Every time a machine is stopped and opened because there's no need, drives cost, and we are now absolutely in the position to support industry like never before in giving them these benefits from the technology available. There is a very good development in this going forward. If you look at the next slide, we talk a little bit about products. We have been chosen as the main development partner for Volkswagen on the all-electric MEB vehicle platform, which is their future platform for their new electric vehicles. That's fantastic. If you take the next slide, we talk about another good initiative, the LEAP engine. This is the new GE engine for aircraft that's being ramped up, and our hard work to get the main lion's share of that program is now paying off, and we are growing strong in this business.
With those words, as a short introduction to this very good initial quarter, I hand over to Christian for more details around the results.
Thank you, Alrik, and good morning to all of you. Some more details starting with on the next page. Thank you. Sales development. Net sales increased with 4.9% in the first quarter, and we still, as you've heard, experienced a healthy growth in the quarter in most of our markets and across most customer industries within industrial and automotive, with a few exceptions like wind. Organic sales increased 7.5%. Currency effect was negative 1.9%, and the structure component, as we've had previously as well, was this quarter 0.7%, related to our divestment transaction that we closed second quarter last year. If you turn page, organic sales growth. Last year, as you know, we grew organically 8.2% on full year, which was equally distributed over the quarters.
The 7.5% organic sales growth this quarter mean that we remain at around 8% year-over-year growth, which is very pleasing, knowing that we now grow from significantly higher comparison values. The working day effect was negative in the first quarter with about one day versus last year. Turning page. Operating profit, and as you might have seen in the press release, and I would like to mention it as well, since it's a change, we will, from this first quarter onwards, only report operating profit, including items affecting comparability. I will come back to reporting changes in the end of the presentation.
If we look at the graph, the reported operating profit in the quarter was SEK 2.625 billion, or some SEK 330 million higher than in the first quarter last year, and it was, as you heard from Alrik, the highest operating profit SKF has reported in a single quarter in history. The 12 months trend on operating profit was SEK 8.9 billion. If you turn page, and we come to the profit bridge, I'm taking you through this, for the quarter from left to right, we had a negative effect then from the divestment that contributed with SEK 32 million in profit last year that we don't have this year. Currency impact was negative SEK 287 million compared to last year. If we go to the operating performance, this was for this quarter, very strong, and increased year-over-year by SEK 649 million with a good leverage.
Our contributions from organic sales and manufacturing volumes increased by SEK 939 million. We saw positive effects from sales volume, from price mix, and from fixed cost contribution from the increased production volumes. Price mix, clearly positive compared to last year. The improvement trend on pricing that we have seen in the previous quarters have continued and gave a clear positive contribution in the profit bridge. Mix was also positive in the quarter, both related to industrial automotive mix and to the distribution OEM mix. The manufacturing contribution included a positive profit effect of about SEK 30 million from increased finished goods inventories. The inventories increased slightly more than in the first quarter last year. Cost development in the quarter gave a negative effect of SEK 290 million. A repo change here as a consequence of what I told you earlier.
Year-over-year effect now includes restructuring costs, which previous year was reported as items affecting comparability, and this is now part of the operational performance and part of the cost development. It was relatively unchanged in this quarter versus last year. We are also from this quarter including the year-over-year effect from Unite in the cost development. No separate bar for Unite in the profit bridge. Unite was in the first quarter positive EUR 65 million compared to the guidance we gave with a positive effect of EUR 50 million. The full year forecast for Unite is still positive EUR 100 million, so it's a minor item going forward, and that's why we take it as part of the overall cost development.
The material cost was in the first quarter negative EUR 100 million versus last year, and we continue to manage to compensate the raw material with positive effects from commercial activities, design and specification changes, and reduced consumption. For the second quarter, we expect the material cost impact to be somewhat less negative, so about EUR 70 million negative year-over-year. The remaining cost development is negative EUR 255 million, consisting of ordinary cost inflation, which is around EUR 200 million in the quarter, somewhat higher than previously. We also had some extra cost related to freight, to manufacturing, due to that we run production now on high capacity utilization and to R&D. These make up the difference of EUR 55 million. For the second quarter, with our positive demand guideline in mind, we expect somewhat higher cost level to remain at negative EUR 250 million, excluding the material that I commented earlier.
In total, EUR 320 million. That was a lot of comments to the profit bridge. If we turn page, performance by customer group. Industrial, organic net sales increased by 8.5%, significantly higher in both Europe and Asia, and relatively unchanged in North America. Operating margin 15% compared to 14% last year. Contribution from increased sales and manufacturing volumes was positive, together with a clearly positive effect from price mix. Automotive organic sales grew 5.5% in the quarter. Good sales growth for both light vehicles as well as trucks. Strongest automotive markets continued to be Asia, but demand was also good in North America and Europe. Operating performance continues to strengthen, and reported operating margin 7.7% compared to 6.8% last year. If we turn page, income statement for the quarter. If we turn page, please, yes. Gross margin was almost flat compared to last year.
Positive contributions from organic sales and manufacturing contribution offset by negative currency, higher material costs, and the general inflation manufacturing cost, and freight, as I already commented. Selling and administrative expenses as a percentage of sales decreased to 13.1% from 13.7%. General inflation offset by productivity, positive currency effects, as well as lower Unite costs. Financial net, a negative EUR 200 million compared to EUR 170 million last year. Exchange rate fluctuations had a negative impact versus a positive impact last year. If we go to taxes in the quarter, we had an effective tax rate of 26.3%, clearly lower than last year same quarter.
This is due to that we have higher profits taxed in Sweden, so lower tax rate, and to the U.S. tax reform, as well as we have a deviation to last year, which was impacted by tax costs in the first quarter 2017 that related to prior years. Earnings per share in the quarter increased by more than 20% and was EUR 3.77. Next page, cash flow. After investment, before financing, excluding M&A activities, positive EUR 254 million versus EUR 64 last year, mainly due to higher operating profit offset by increased working capital, while investments were just slightly higher than last year. 12 months trend was EUR 4.3 billion. Next page, please. Net working capital 31.7% of sales at the end of the quarter, 0.8 higher than the same quarter last year. Ratio was negatively impacted by currency.
However, also adjusted, it was somewhat an increase in the quarter. We see good progress when it comes to trade payables. Receivables ratio improved somewhat versus last year, 19.1%. However, if you compare it to end of last year, it increased a bit. I would say that's due to the Easter weekend that was in the end of March, which impacted the day of payment from some of our customers. Inventory ratio increased to 23.4%, and we have continued to have good availability, wanted to keep the service levels up with increased customer demand. As you've seen in the P&L, we do see positive effects from us being able to meet both the OEM and the aftermarket demand in our profitability. If we turn page, net equity ratio continued to improve. End of the quarter, we were at 66%, then excluding pension, we're down to 29%.
Next page, guidance for 2018 for the second quarter. Finance net unchanged, about EUR 200 million negative. Then we have the currency impact, where we have two references, end of March, as you have in the slide. We expect EUR 160 million negative in the second quarter. If we take the exchange rate of April 24, it's improved a bit, so it's negative EUR 100 million for the second quarter. We still believe tax rate will be 29% and no change to the investment level. Additions to plant and property, EUR 2.4 billion. As I said, coming back to Reporting changes, and the first one was already mentioned, that we now have one operating profit line, including ISE. That will not be separate reported. It will report the part of cost development or where it belong in the profit bridge, and we will not report an adjusted operating profit.
From this quarter, we will not give any sequential demand guideline, only a year-over-year demand guideline, and I will soon come back to that for the second quarter. Finally, we have also done a slight adjustment to the segment definition in our sales reporting, and this in order to align it with the general industry standards. You have the segment changes on the right side of the slide, and I will not go through it, but please call us if you have any questions on this. With that, I leave the word back to you, Alrik.
Just to summarize, continued growth in Q1, record quarter, both as far as sales and operating profit. That we are expecting to see this continue into Q2 with higher volumes year-over-year. A really good quarter, and I am proud of SKF today, I must say. It feels good. If you look on our demand outlook, I will read it to you for the sakes of good order. Demand compared to the second quarter 2017. The demand for SKF's products and services is expected to be higher for the group, including industrial and automotive. Demand is expected to be higher in Europe, significantly higher in Asia, and relatively unchanged in North America and Latin America. With those words, I hand over again to you, Patrik. Thank you.
Thank you, Alrik. Operator, please, now we move to the last slide. We move into Q&A. Please go ahead, operator, please.
Thank you. Ladies and gentlemen, if you'd like to ask a question at this time over the phone, please press the star or asterisk key, followed by the digit 1 on your telephone. Please ensure that the mute function on your telephone is switched off to allow your signal to reach our equipment. If you find that your question has already been answered, you may remove yourself from the queue by pressing star 2. Again, please press star 1 to ask a question over the phone. We will pause just for a moment to allow everyone the opportunity to signal. We'll take our first person from the queue. Gael de-Bray from Deutsche Bank, please go ahead. Your line is now open.
Thank you very much, and good morning, everybody. I have actually two questions, please. The first one is about the Chinese market trend. How do you see your market share actually trending in China? You've again delivered pretty strong growth there, and I was curious to see if you were actually outperforming the market, and if yes, in which areas? The second question is about the automotive business. I think the turnaround of this business has now been largely completed, with the margins getting closer to the 8% target. The growth momentum is apparently fading a little bit. What's next here? Do you still expect the division to be able to contribute positively to the group's earnings growth momentum in the next few years? Thank you.
Well, this is Alrik here. If you start with the Chinese question, it's at this point, just one quarter hindsight to be truthful of knowing exactly how much market we are gaining and in what segments. I tell you, it's difficult for me to be precise about it. In general terms, our assessment is that SKF is now gaining position in the markets. When you look at the key markets we're in, we're doing fine. We have had a relatively good delivery performance, and I think our customers are happy with us. As far as the automotive, yes, I'm really proud of the teams. They have done an excellent job to actually get to what were our expectations. Now we are looking, of course, at many new interesting initiatives.
The automotive business, if you have the right technology and the right offerings, will, of course, be able to give good contribution to the SKF group going forward. I see no reason why not. We talk about electrification. We talk about new powertrain solutions, et cetera. This is a positive in my mind for us, because rest assured, the traditional powertrain will stay for quite a while, at the same time as we have the new powertrains coming in. If you look at the cars that are now being launched, they're mostly hybrid. Yes, there are some pure electrical vehicles, but the big volumes for the years to come will still be with the traditional powertrain.
We are, as you have seen with the Volkswagen nomination, for instance, a key player in the electrification, as well as a key player in wheel bearings and chassis bearings and in the powertrain. There's no reason why that could not continue.
Okay. Can I just have a follow-up on the Chinese situation?
Yes.
Have you seen your Chinese competitors following on your price rises?
If you recall, they were actually the first ones to start compensating themselves already two years ago or one and a half years ago, when we clearly saw the turnaround in the second half of 2016. Definitely.
Okay. Thanks very much.
Thank you. Now we'll take our next person from the queue, Klas Bergelind from Citi. Please go ahead, your line is now open.
Yes. Hi, Alrik and Christian. It is Klas from Citi. I will start with the favorite topic, which is price mix. It seems like price mix is the key driver behind the improved profits, manufacturing only impacting the bridge by EUR 30 million. Depending on the pure volume drop through, I get price mixed between 1.5%-1.8%, which is obviously a big improvement quarter-on-quarter. First, if you can confirm if that is the right ballpark figure, and then if we can try and break down the price mix a bit. Am I right that mix and distribution pricing was perhaps 50 basis points each, and then 50-100 basis points from the OEM on the annual contract starting to kick in?
Klas, it is Christian here. As we have commented, and you are right in that we have a clear positive step up here, sequentially here. I do not want to comment your absolute judgment there on what you gave, but it is clearly going in the right direction when it comes to pricing. As I said also, when it comes to mix, the important factors in the mix is on one hand, as you know, from the margin, industrial versus automotive, which was positive, and you have the distribution versus OEM, which was also positive. By us being able to serve the industrial distribution of the market in a very good way.
On the OEM side, is it around one-third of this annual contract kicking in from January?
As we used to discuss, we have so many customers, this is locally and customer by customer set up, what date you have for the change. As we have said, we are on this ball. We have been on it for a while, the longer this positive business climate remain, obviously the more OEM contracts are expiring and pricing is on the table, eventually adjusted in the contract to come there. For sure, some of this came in first January, some of it comes in at other points in time. The trend is positive. We have been talking about this now, I think that we are now proving that what we have been saying all along is true, in a way. That there is pricing power, SKF is on the ball.
My follow-up was on raw materials. Did you say EUR 70 million negative year-over-year in the second quarter, Christian? Should that stay at that level for the rest of the year per quarter, given that the year-over-year comp in the bridge is similar from here? Are the increased steel prices in the quarter going to drive a bigger impact year-over-year into the second half?
No, I don't think so, since we had. To be honest, I haven't looked into the quarter-over-quarter. We follow, obviously, the raw material price trends carefully, and that's why we are on minus EUR 70. We had cost increases that creeped on us already in the second quarter last year, that continued. I would say that the steel price as such has been quite, surcharges and so on, has been on quite stable level now. I cannot comment on the second half of the year, but I would not expect it to increase in the second half of the year, for sure.
Thank you.
Thank you. Now we take our next person from the queue. Peder Ramel from Handelsbanken Capital Markets. Please go ahead, your line is now open.
Yes. Thank you. Well, Christian, thanks for the clarification on the operating profit, the waterfall there. You mentioned that the production helped the profits by EUR 30 million, which I appreciate. Could you please explain how that works since the inventory build was quite significant? It was, I think, EUR 1.3 billion or so quarter by quarter, and last year it was maybe half of that level. Is there less finished goods, or could you please help me understand that?
I'll try. What you consider in, let's say, the inventory contribution in the bridge is the sequential bit. Obviously the increase from last year, that has been happening gradually during the 12 months, let's say. If you take the sequential increase, and we always have a seasonality in Q1 because we have, for example, in automotive plant shutdowns over Christmas and so on, and then they are ramping up again. If you take the Q1 sequential inventory build last year, and you take the same this year, we have built slightly more. Not much, slightly more finished goods inventories this year, and that's what I'm saying corresponds to EUR 30 million profit contribution in the bridge from inventories.
Yeah. If I can just-
Obviously-
Oh, yeah. Okay.
Yeah. Obviously, we have contributions from the overall, the sold volumes in production as well. The inventory build, which we usually ask for, is EUR 30 million.
Okay. I get back to you on that one. Thank you.
Thank you. We now take our next person from the queue, Marcus Almroth from Kepler Cheuvreux. Please go ahead, your line is now open.
Hi, Marcus Almroth here from Kepler Cheuvreux. My first question is on pricing. I know it's difficult to quantify, if you set the beginning when you raised prices last year to distributors, and you look at your entire customer base, how far in are you? Are you 70% in, so 70% of your customers have been impacted by price increases? If you could help us a little bit on that. I just want to ask about potential bottlenecks in the supply chain. You talked about last quarter that you had most of the bottlenecks behind you. Is that unchanged, or have you encountered new bottlenecks in supply chain? Thank you.
On the pricing, you started on distribution, obviously we have implemented price increases in distribution, which means that has impacted the full chain of the distribution network. I cannot quantify the percentage on the OEM that has implemented price changes in the contracts. Again, we are pushing on this. We are on the ball. I think you clearly recognize that this is happening. It happened on quite the firm. We said it's slow and steady because our ambitions have been higher last year, quarter by quarter. We have a somewhat bigger step in the first quarter, we expect to continue to have a clear positive bridge effect from price mix also in the second quarter. That's what I can give you on this. You had a second question also, or no?
Yes.
Bottlenecks. Yes.
Supply chain.
What we have, you refer eventually to the extra cost that we have. Imagine when you run on high utilization, both in our factories and in the supply chain with suppliers, you have to take costs for rush transports, because simply, you don't get what you need in your plants on time. You take this extra cost in these type of markets in order to serve the customers. That's what you do, and that's natural that it comes some extra, and there could be bottlenecks on transports also, and you have to take another route, or you have to fly things, and so on. This happens. Also in the plants as such, you have to take on sometimes an extra shift, a night shift, more expensive and so on. This is nothing strange at this part of the business cycle.
Okay. Thank you very much.
Thank you. Now we take our next person from the queue. Andre Kukhnin from Credit Suisse. Please go ahead, your line is now open.
Yes, good morning. Thanks very much for taking my questions. I'll start on the outlook. You guided for higher year-on-year, which I think in your definition is the range of 4%-8% growth. You've just done 7.5% in Q1 against a negative days effect, which is at least, well, a couple of points of growth, maybe a point and a half. Just wanted to check that, firstly, your outlook is still on an all-in basis, so it's not days adjusted. If it is, then what is behind that sort of implied slower run rate, even at the top of that guidance range of 8%, compared to what you've just done in Q1? Is there anything in there that you expect to grow at a slower pace? Is it just conservatism?
No, again, it's a demand guideline we have. It's a demand guideline, and organic sales include price mix. Back to that. Demand guideline, we take it as it is on the calendar. We don't do any kind of seasonal adjustments and day adjustments and so on. What you said, at least when we calculate one day in a quarter, it is below 1%. Or sorry, one day in a quarter is slightly more than 1%.
Yeah.
I don't know what to say there, but you're right.
Okay. It's clear that the price mix could be making a difference. Thank you. Just because you report now all in, can I double-check if there's anything in Q1 of a one-off nature, whether operational or not, whether positive or negative?
No. If you talk restructuring costs year-over-year, it's not in quarter one.
Okay, no revaluations of inventory or anything like that?
If you talk about whether our guidance and so is an underlying stable performance, I say yes to that. We don't have any special things in the quarter that makes the performance that you see now unique or
Okay, great. It was just to double-check, and obviously the move to all-in reporting is a move towards high quality. Thank you. Thanks so much for your time.
Thank you.
Thank you. Now we take our next person, James Moore from Redburn. Please go ahead. Your line is now open.
Yeah. Morning, everyone. I have a couple of questions. I'll go one at a time if I could. Just on the price mix. You've always been quite clear in the last 40 years about that number, and even in the last couple of years, been relatively clear. You seem to have abandoned any transparency on it. This quarter, maybe I could try a little harder. Is it closer to two or one for the quarter? That's my first question.
As we said, we don't comment on the number.
Okay. Just secondly, to follow up on Andre's question, are you saying that adjusted EBIT, had you reported, is identical to reported EBIT? The non-recurring item is zero in the quarter?
No. Sorry. The bridge effect is zero, but you have in absolute terms, you have in the same range as you had last year, which were around EUR 60 million. Sorry if I misunderstood the question. We have discussed this. Certainly we shave off some costs. We are working on our footprint projects, which have some restructuring costs. You have that on roughly the same level as we had last year.
Okay, thanks. Earlier, finally, on cost development, I think you mentioned EUR 250 million, excluding the raw material, for the second quarter.
Correct.
Am I correct in saying that includes your Unite positive?
Yeah. For second quarter, if you have a full year Unite effect, which still remains as we guided last quarter of +EUR 100, and we had a +EUR 65 in the first, you don't have much of Unite in the second quarter. Yes, the EUR 250 includes Unite.
Thanks. Maybe finally, I could Another second final question. On China, could you help us with the pace of growth of China versus the rest of Asia Pac? Is there a big difference between the two?
China is still the major economy in that region, as you can imagine. With that kind of growth figures, China is doing very well.
Thank you very much.
Thank you. We'll take our next person from the queue, Ben Oglou from Morgan Stanley. Please go ahead. Your line is now open.
Good morning, and thank you for taking my question. I guess it's a question for Christian. It's a big picture question around how we should think about the cadence of your margins in any given year. When I look at the last 2 years, the Q1 margin has actually been the high watermark for the year. Obviously, I think there are inventory and other effects in there. When I go back further, and I look all the way back to 2011, you've actually seen quite big step-ups between your Q1 and your Q2 margin and into the remainder of the year. I fully realize that there are some inventory effects, all kinds of different things going on here.
In your mind as the CFO, is there any normal seasonality or is there any normal pattern that we should think here, in terms of margin?
Your question is if seasonality has changed from previously in history, and if we have a certain seasonal pattern on margins. Spontaneously, obviously, volumes are somewhat different in the quarters. They are not 25%, even though you don't have a dramatic difference between the quarter, but that certainly to some extent impacts the margins. There is nothing else in our business in terms of that you have segments that are buying more or less on the big picture that influence the margins in the quarters, at least as far as. Obviously, the industrial automotive mix could be different, but I have to come back and look to that.
There is one. This is Alrik here saying. There is one thing that we have been working diligently with, if you know, this is try to avoid the pre-buys in the end of the years. Previously, many distributors were buying to reach a bonus in the end of the year, et cetera. We have diligently, during the last 3 years, worked to get over to a COGS, meaning they are getting whatever incentives from SKF based on what they sell with the transparency as opposed to what they buy. We don't get these industrial dynamics that we used to have. You remember. That is a change.
That's very helpful. Thank you. Then just one final question. Just on the price increases, and I realize that you're looking at lots of different moving parts. Geographically, where did you see the strongest reception, and where has it been toughest?
Well, it's interesting. This is not a geographical thing, actually. It's interesting to see that some parts of the bearing market is not global, meaning it's more difficult to sell the bearings because of their size or whatever outside of your region. Basically, the bearing market is global. There is actually a global trend. Here, in a situation like we are right now, I think there's pricing opportunity everywhere. Of course, there will be certain segments where you as a company are stronger, and there are other segments where there's more of a contested market. There are customers where you are more differentiated than in others, and this is like it's always been. I think that this is what I've been trying to tell, that it's like it's always been. It's not a new dynamic now than it used to be before.
That's great. Thank you very much.
Thank you. We take our next person from the queue, Markus Mischel from UBS. Please go ahead, your line is now open.
Yes. Hi, good morning, everyone. Two questions from my side, please. One, let me ask the OEM contract question in a different way, if I may. If you look at the last four quarters, and aggregate over that, is it 20%, 80%, 50% of contracts that have been renewed at new price levels? Where would you put that number, roughly? Secondly, on inventory, I'm slightly confused. I think if we go back to the discussion three months ago, last quarter, the estimate was SEK 300 million finished goods built in the quarter. It sounds like now of the SEK 1.3 that we built overall, maybe sort of smaller than the SEK 300 million, Sigurd, was in finished goods. What happened in the quarter, just in terms of the incremental inventory build there? What does that tell us for, I think, momentum demand into Q2, right?
I understand you're no longer giving sequential guidance, but I'm just trying to understand the relative moves within inventory a bit better here. Thank you.
If we start with the pricing question, I just can tell you there is pricing power in the marketplace, and we are exercising our ability to compensate costs and improve our margin. The kind of details, how many contracts or whatever, it is not relevant for me to even speak about that. The truth is, rest assured that there is a positive dynamic in the marketplace, and there is pricing power.
If I try come back to your inventory question, if you look in the balance sheet, then knowing what happens to the currency situation, as we have talked about, you have a lot of currency in the balance sheet with the weaker Swedish crown. It's a lot of currency in the overall. If you look at the content of inventories, we used to talk about two things, the manufacturing stock or the channel stock, which includes raw material, it includes components and so on, and it includes work in progress and so on in the factories. You have finished goods inventories. You're absolutely right. When you talk about the EBIT effect, the value add that you get, that you only get on the finished goods side. You don't have any value add by having steel bars in your inventories.
What we guided for in the previous quarter was that we expected the finished goods to increase with SEK 300 million. What I am saying now is that it has increased slightly more, and it was SEK 300 million last year as well. In the guidance, we said we will build the same amount this year as last year. Now we built slightly more, and the slightly more is SEK 30 million in EBIT effect. Was that clear?
Yep. Thank you.
Good. Thank you.
Thank you. We take our next person from the queue, Andreas Koski from Nordea. Please go ahead, your line is open.
Thank you very much. Thanks for taking my question. Can you hear me?
Yes.
Yeah, perfect. I'm a bit surprised to see the gross margin being unchanged year-over-year when you're able to increase your prices and you get support from your inventory build. I thought we should see higher gross margins coming through from higher prices. Just if you can explain why we are not seeing higher gross margins and also what to expect going forward.
I would say the main thing that changed what you say, I don't want to go into details of that we had divestments as part of, and then some decimals on that. The big thing that changed the correct thing that assumptions you have is the currency effects. If you look in our currency composition, it's a lot of transactional effects, the transactional effect is fully coming into the gross profit. Then we have also negative effects from the translation effects in the growth. I would say it's largely currency. Except for that, we are increasing our gross margin. The positive effects from price mix, from manufacturing volumes is more than offsetting the cost increases that I have commented.
Yeah. Okay. Underlying gross margins are actually up?
Yeah.
Yeah. Excluding currency impact. Okay. Secondly, on the general cost inflation, I think you have previously guided for some SEK 600 million per year. Should we now expect that to be closer to SEK 1 billion this year and next, or how to think about it more than next quarter?
No, I do not expect it to be SEK 1 billion. I tried to estimate it since we have used that language, what is underlying cost inflation, what is extra cost that we run very high on the overall operations. We should not expect it to be that high, but slightly higher. We had, and we talked about that before, I believe, a slightly higher salary increase, for example, in Central Europe, in Germany. That what we had previous years. It is somewhat an increase. I have to come back to that on the overall full year basis. I do not have an answer to that.
Yeah. Lastly, it sounds like you have built finished goods in constant currencies of around SEK 400 million during the quarter, implying that you have increased raw material inventories quite significantly. I guess that will be turned into finished goods in the next couple of quarters. What to expect in inventory build finished goods, constant currencies in Q2, Q3?
I will keep your first conclusion on raw material. Your question is what will happen to our finished goods inventories in Q2?
Yeah.
As you've seen in our demand guidance, we do have a high demand also, things are going out as well. We presently don't expect to build a lot of finished goods inventory in Q2. We don't expect that. I would say relatively unchanged.
In Q2 last year, you built by EUR 400 million?
Correct.
Yeah. Okay. Thank you very much.
Thank you. As a reminder, ladies and gentlemen, star one to ask questions, we'll take our next person, Johan Sjöberg from SEB Bank. Please go ahead, your line is now open. Johan, please go ahead. Your line is now open.
Sorry. Excuse me. I had a couple of questions. Starting off with the comments you made, Alrik, on the volumes in the quarter, and you're trying to hold back on attempts to pre-buy here. Could you say something?
No. I didn't say that.
Oh, sorry.
What I was trying to explain was when you look at the seasonality going back, we used to have a phenomenon in SKF prior to 2015, where to reach the end-year sort of bonus schemes, many distributors bought a lot of goods by the end of the year. That we have diligently changed in the last years, and that is changing somewhat maybe the seasonality. As far as distributors, we don't think that there is an excess inventory in the distributor network at this point.
Okay, great. Thanks so much for clarifying that. I know you don't like to talk about the future, what you're going to achieve in the future, but rather what you have achieved in the past year. Could you say something about the prices for Q2? I hear from other distributors that there is a second price increase to distributors right now pending. Can you confirm that?
Yes.
Good. Thank you. That should, with the typical delay in OEM contracts, should have an impact upon OEM contracts during the second half and also possibly the first half of 2019 if you look at history, right?
Well, it's always a situation with old contracts that when they come due, there's a discussion about what is the reasonable price level. Right now, of course, it is the seller's market, and there's an opportunity to improve your price also going forward.
Got you. Also talking a little bit about your manufacturing footprint, what you're doing right now. You've earlier highlighted that also, you highlighted in your annual report on closing down facilities. How is that activity level doing right now considering the strong demand? Is that on hold? Are you waiting for kind of slowdown maybe in volumes before you start to reinitiate those initiatives?
The initiatives are never on hold, and they can of course never be publicized before they are actually about to happen. There is a certain truth in what you're saying. Even if you have a new setup and you want to change a line or consolidate footprint, it's very difficult to do when you're at the same time struggling
Working full-time to serve the marketplace. You are right, there is a certain slowdown, of course, in our ability to do this project currently. In addition to that, maybe the ones that you have seen in terms of press releases, a couple of plant closures and plant moves in the U.S., obviously they are communicated and they are implemented. Could be some quarter of delay and so on due to the demand situation. They are not stopped. That's one of the reasons why we have still some restructuring costs in the quarter here related to these footprint changes.
Okay, got it. My final question. When you talk about prices, are you mainly referring to bearing or are you referring to your whole product sort?
Oh, everything, of course. Everything.
Everything. The reason is that there has been some doubts about this with your peers, we have been trying to tell you this is not correct. I think now we are proving that our standpoint that there is a pricing power with SKF is true. I hope everybody puts this question behind them now and start believing us for real.
Yes, sounds good. Thanks so much for your help.
Thank you, ladies and gentlemen. That will conclude our question and answer session for today. I would like to hand the call back to Patrik Stenberg for any additional or closing remarks.
Thank you so much. Thank you for all your questions. If you have any additional questions, you are more than happy to give me a call. On the last slide in the back here, you will see some of the upcoming events when we will be able to meet you in person and also through video conferences and so forth.
I want to thank you for assisting today's conference, and it is a record quarter for SKF. We are performing well, and I'm looking forward to continue to have a good dialogue next quarter. Thank you very much.
Thank you, ladies and gentlemen. That will conclude today's SKF Q1 2018 Results Conference Call. Thank you for your participation. You may now disconnect.